Economics

Outsourcing

Take this job and ship it

THE hive mind behind the Modeled Behavior twitter feed has been trying to goad economic types into defending outsourcing, now the subject of intense political debate thanks to Mitt Romney's career at Bain Capital. The direct provocation of MB's ire is, I think, a series of posts from Paul Krugman. In one, he writes:

[R]ecently the Washington Post added a further piece of information: Bain invested in companies that specialized in helping other companies get rid of employees, either in the United States or overall, by outsourcing work to outside suppliers and offshoring work to other countries.

The Romney camp went ballistic, accusing the Post of confusing outsourcing and offshoring, but this is a pretty pathetic defense. For one thing, there weren’t any actual errors in the article. For another, it’s simply not true, as the Romney people would have you believe, that domestic outsourcing is entirely innocuous. On the contrary, it’s often a way to replace well-paid employees who receive decent health and retirement benefits with low-wage, low-benefit employees at subcontracting firms. That is, it’s still about redistribution from middle-class Americans to a small minority at the top.

And this means that Bain’s activities are part of the really big story about America these past three decades, which isn’t about jobs moving overseas, but about the rewriting of the social contract, with income shifted away from ordinary workers and toward the Masters of the Universe.

Those of us who learned our economics in the 1990s remember well when Mr Krugman instead wrote things like this:

[M]oral outrage is common among the opponents of globalization--of the transfer of technology and capital from high-wage to low-wage countries and the resulting growth of labor-intensive Third World exports. These critics take it as a given that anyone with a good word for this process is naive or corrupt and, in either case, a de facto agent of global capital in its oppression of workers here and abroad.

But matters are not that simple, and the moral lines are not that clear. In fact, let me make a counter-accusation: The lofty moral tone of the opponents of globalization is possible only because they have chosen not to think their position through. While fat-cat capitalists might benefit from globalization, the biggest beneficiaries are, yes, Third World workers.

Now, it's possible to read Mr Krugman in a charitable way here. One could argue, as he once did, that globalisation was largely a story about how improved transportation and communication technologies allowed billions of very poor workers to join the global economy and greatly improve their living standards and global welfare in the process. One could say that, economically speaking, this was a good thing for rich economies. But one could add that one side effect of globalisation was a weakening of important countervailing political institutions in rich countries, which removed a check on the concentrated political power of owners of capital. And one could then say that owners of capital have used that political power to systematically chip away at instruments of redistribution. Globalisation represents a Kaldor-Hicks efficiency improvement, in other words, but it takes the machinery of the welfare state to make it Pareto improving. Rather than make sure that such machinery is protected, one could argue, the owners of capital who've gained from globalisation have simply allowed it to rust and decay. Indeed, you could even go so far as to say that by allowing such redistributive engines to fall apart, owners of capital have contributed to growing erosion in support for globalisation. Reckless outsourcers are actually the enemies of liberalisation!

Maybe. But if that's what Mr Krugman means, he should make the case forthrightly. As it is, the posts cited above read like a straightforward argument that outsourcing and offshoring are bad for labour, full stop. And that's wrong. If a job can be done more cheaply, then changing production methods to do the job more cheaply frees up resources that can then be used for other things. Unless there is a macroeconomic policy failure, those resources will be used for other things, ensuring that unemployment doesn't rise. Workers should earn their marginal productivity, and if we're not happy with those wages, we should support redistributive taxation, or identify productivity-enhancing public investments in education or infrastructure. We should not heedlessly create worker cartels that fight with firms over the right to capture rents.

Now I can't say for sure, but I suspect that Mr Krugman might respond to that argument by saying that it's hopelessly naive. I think he might own up to being radicalised by policy over the past decade or so and say that he's discovered that economic policymaking, as practiced in America, is much different than what textbooks suggest ought to occur. Political economy and bargaining power are everything, he might argue, and the inefficiencies associated with a class-conscious, organised labour force are a price worth paying for a check on the class-conscious wealthy who are all too willing to use the political system to protect their interests and gobble up rents. Just look at the enormous wealth and waste in finance, he would probably shout, and the appalling, intimate connections between Wall Street and Washington.

And honestly, I have some sympathy for that perspective. But here's where I differ from that imagined Paul Krugman. First, I think the process of globalisation, which has moved billions of people out of dire poverty, is worth defending loudly and proudly, even if it came along with a costly side order of dysfunctional American politics and policymaking. We have a moral responsibility to be very clear about what aspects of globalisation we think should change and why, because the cost of encouraging a broader backlash against the process of liberalisation, with all the great good it generates, is simply too high.

And second, it seems to me that an effort to restore the bargaining power of labour by having a showdown over outsourcing or by trying to reinvigorate the labour movement is destined for failure. The rise in worker bargaining power that occurred in the first half of the last century was a product of social movements, but those movements were enabled by the production technologies of the time, and it is the dissolution of those production technologies that has been most responsible for the weakening of labour's position. As Mr Krugman understands very well (his work on the topic helped earn him a Nobel Prize) the transportation technologies of the industrial revolution dictated in favour of large, industrial agglomerations. Geographic concentration enabled worker solidarity, and the benefits of the agglomeration meant that employers couldn't credibly threaten to move elsewhere. But the days of the large, urban industrial agglomeration are gone.

If labour is to capture more of the producer surplus—or have more of a say in Washington, for that matter—it will be as a result of a social evolution that matches the production technologies of today. That's a much, much harder process to think about and talk about than a call for the return of the glory days of labour. It's certainly not the sort of thing that lends itself to deployment in the binary dialogue of a presidential campaign. The truth is that Bain didn't really do anything wrong by outsourcing. It could have not done it, but that would primarily have created a profit opportunity for someone else. It may say something about Mitt Romney that he was the man who opted to take the profits. But the nature and distribution of economic activity is about the interaction between technology and institutions, and not about whether an individual capitalist tries to be fair or not. It's not Mitt Romney's fault that the median worker hasn't gotten a real pay increase in over 30 years. And Mr Romney's Bain experience might cost him the election, but that's not going to bring real pay increases back, either.

For much of the postwar era the GDP of the USA has approximated one-fourth of the world's total output. Other things being equal, that means that each year the USA garnered one-fourth of the world's wealth. (Just after the war American produced HALF of the world's output of goods and services!) There is nothing wrong with this -- the country produces this wealth via an educated workforce, bountiful natural resources, a sound capitalist instinct and, most importantly, a political system of rock-solid stability.

But, we must have known it wouldn't last. How, with only 6% of the world population, could the US pocket each year one-quarter of the world's output? There are two answers to this, the first of which is the rest of mankind is stupid and Americans are not. Anyone who ever watched "Hee-Haw" or bought a Nehru jacket knows better. The second, more likely explanation, is that we got a head start and now the late-bloomers are catching up. Well . . . it was nice while it lasted.

There seems to be an odd conception among the public that when a corporation out-sources it shoves all its productive facilities in a manila envelope and Fed Ex's them to Asia. This misconception prompts the use of the most over-worked explanation for Everything for this generation: GREED. (I had dinner with some public school teachers a few months ago who were furious with a local firm that deployed capital overseas "just to make more money." The only response I could think of to this was to stare intently into my wineglass and sigh.)

The world is profoundly ungrateful. We gave it VE Day, the assembly line, rock and roll, 8-track tapes and global-warming hysteria and what is our reward? Why, the world continues to surge ahead economically in places we used to know only from watching "Gunga Din" or "Tarzan." Mr. Romney abetted the world in this by providing capital that helped elevate the living standards of lesser breeds without the law. Hell of a nerve!

I commuted for decades into NYC and was often fooled into thinking my train had left the station when it was just an adjacent train starting its journey down the track. For thirty years now, Americans have sat in the station assuming they were in ones in motion when, in fact, it was the other fellow's train that was slowly leaving us behind. Now, we've started to wise up.

Americans have tried to keep themselves prosperous by borrowing money they cannot pay back and going to the mailbox each day in hopes of a government check. For instance, last week we learned that the number of new disability SS enrollees (a flourishing racket for both lawyers and the work-shy) exceeded the number of new jobs created during May. In other words, government is increasingly becoming our preferred source of income.

We're being taken down a few pegs by "furriners" who are as smart as we are, probably work harder and, increasingly, are better-educated. This is not Mr. Romney's fault.

sir, with all due respect, you have a lot of facts misconstrued.
i personally have overseen the outsourcing and off-shoring (one and the same in my book) at 3 fortune 500 companies (seperate companies). i have sat in an office and watched a 40+ year old white woman crying before me, this was the first job she'd had since graduating college, and now she was being told she had to train the person in india who was going to take up her responsibilities (may i also mention that the CIO of this company was indian, as are the CIOs or key executives at most companies that decide to off-shore to india; they also tend to have an interest in the entity to which the work will be off-shored).
i have seen the cavalier attitude that the people who initiate these off-shoring initiatives have for the workers (american) who are set to lose their jobs (we'll save $xx, here and $yy there).. they don't speak it, but their attitude is "f&ck the american workers"; i have seen the ineptness of the management in india who were to oversee these off-shored initiatives -- simple things could not these people do.
so as one who has been at the forefront of such initiatives, i will say this much... (a) it is not necessary, (b) it truly hurts the american worker, (c) the people who make these decisions could care less for the american worker.
another point. only a handful of the labor pool in the countries that receive these 'off-shoring' contracts benefit. go talk to the child laborers in asia; go talk to the people in india (many millions) living in squalor; go talk to the mexicans who have to sneak into the us.... the benefits are far overplayed; only the 'elite' of the foreign nations (india, china, phillippines, mexico, etc) benefit.
government has no control over business performance. there are primarily 2 areas in which government of any sort can influence business. (a) regulation; (b) taxation. as for regulation, business have massive lobbying efforts on capital hill to minimize regulation. along with that, business offer campaign contributions as well as 'potential' future employment to 'favorable' congressmen (bribery by another name). hence a good chunk of regulation is in favor of the larger business. the smaller business, well, they are truly not meant to succeed, as their innovation threatens the large businesses (hence all business owners pointing fingers at obama or bush or clinton or reagan) realize, they are inept in these matters. as for taxation, a business that pays their 'expected' tax rate should fire their CFO. the tax code is massive simply to accomodate all the attendant loop-holes. a good CFO will employ some excellent tax accountants and tax lawyers to comb through the tax code and identify all applicable loop-holes. financial strategy will then be designed to accomodate such loop-holes. that is why there exists so much resistance to a simplified flat tax system; as this would obviate all loop-holes.
finally, labor movements arose due to the abuses of business (american).once upon a time, american workers were essentially 'paid slaves'. they had no rights. hence the labor movements arose to protect the rights of said workers. problem is that these labor movements grew into leviathans and were so engulfed in political manuevering that they no longer represented the interests of the workers. that is the situation today.
all in all, off-shoring is not necessary. i've seen the numbers. after the sunk costs are recovered, the savings are in the magnitude of 50% in production costs. factor in shipping and duties, and that comes to about 40%. factor in loss of good will and morale at home, and that brings the savings down to about 25%. this 25% could be re-couped were operations maintained at home through several means:
a. full utilization of technology to attain maximum efficiency gains
b. re-structuring these companies along process based organizational frameworks and employing six sigma methodologies to maximize productivity
c. eliminating middle and senior management and the bulk of executive management to fully streamline the organization
d. utilizing the workforce as human capital (assets), not repetitive task robots
e. re-writing GAAP to recognize human resources as assets on the balance sheet, as opposed to line items on the income statement.
f. eliminating stock options as part of the compensation package for executives, instead rewarding executives with bonuses based on 3 things: (a) how well the company is meeting its long-term (5+ year) strategic objectives; (b) the morale of the workers (c) the citizenship of the company (how well it is contributing to the overall health of its community).

The whole post is a straw man argument. He re-imagines Paul Krugman and then knocks down a "re-imagined" Paul Krugman.

If you disagree with the man disagree with the actual man, not what you wish he would say in your head.

The author also completely discounts the complexities of Krugman's 90's writings. Globalization was supposed to create a more competetive world overall which traditionally speaking would improve the market and loower unemployment and misery everywhere. In reality Third world workers are paid little more than what they would traditionally be paid (just enough to attract them)and the savings are pocketed by the company leaving whole american towns to rot. In some cases rather than lifting up third world workers, companies went so far as to engage in slave labor practices such as confiscating passports and not paying workers enough to save for a return flight home.

Globalization's theory was sound, it's practices however are suspect. Finally in the 1990's Americans as a whole could afford to care about third world workers. Now we just want to feed our families and keep a roof over thier heads.

"If a job can be done more cheaply, then changing production methods to do the job more cheaply frees up resources that can then be used for other things. Unless there is a macroeconomic policy failure, those resources will be used for other things,"

Yes, those resources are used for other things. Unfortunately, those other things more frequently seem to be manifest in the form of bonuses for executives.

Most proponents of globalization should not forget that the gains of trade have to be redistributed. The classical example are workers who lose their jobs because it is shipped overseas. If he could pick up any other equally paid job without a long search, he couldn't care less about globalization. However, the truth is, he cannot easily pick-up any other equally paid job, hence he loses. Of course there also some gains for him, as he can buy some products cheaper than before.

So, we have 4 groups of people who hav potential gains from globalization, the workers in the west (Europe and N.A.), the workers in Asia, shareholders and ceo's in the west and shareholders and managers in Asia. The question is now: who gains from globalization? Clearly the shareholders and the managers in the west and Asia, possibly the workers in Asia and whether the workers in the west profit from it is doubtful (losing job, less social security, etc.).

So we have the situation that in Europe and N.A. a minority wins from globalization whereas a majority loses from globalization. Politicians and many economists need to be reminded that the gains from globalization need to be redistributed fairly, otherwise the electorate will be against globalization.

The main problem I see in globalization for the developed world (such as the US, where I live) is that it has pushed wages down here without a concurrent reduction in the cost of living. When wages go down (or stagnate, which is the same thing when inflation is added) but the cost of living stays the same (or rises due to inflation) because of a "race to the bottom" it's bad for the developed world.

It's nice that people all around the world are having their standard of living raised, but don't expect those who've had their standard of living lowered so it could happen to be particularly happy about it. If they become unhappy enough (and we're gettin' there in the US) don't be surprised if the electorate votes to "end" the US participation in globalization by electing a lot of trade protectionists.

Q1. Has globalisation increased the standard of living for the entire world?
A1. I'd say yes.
Q2. If the world is getting richer does the "rich" world have to get "poorer"
A2. Not necessarily (its not a zero sum game) but its likely that this will happen. Its definitely likely that the "rich" world might feel poorer in comparison to the rest of the world.
As I believe in fewer people starving to death (and I'm a free trade fanatic) I'm a "believer" in globalisation. Having said that some outsourcing and offshoring is regulatory arbitrage and not desireable. As energy prices rise to higher levels and working conditions improve in the rest of the world we should see "localism" reasserting itself.
As an aside much of the outsourcing and offshoring I have been involved in rarely achieves the cost savings envisaged and often leads to poorer service for the customer. Sadly as the workers that used to do the job are no longer available it takes years for the company concerned to admit they shot themselves in the foot and
start to insource the work.

For the sake of the argument, let us consider strictly outsourcing within the same country; i.e. moving some of the departments from direct employment to some sort of business relationship outside of direct line of command (it can be as simple as spinning off the IT that you have into a separate company and creating a business relationship).

The problem with outsourcing is that while savings are often upfront (this is where Bain took its cut), the bill often come a lot later, at the time when Bain took the money and went away.

Typical problem #1: conflict of interests. Whoever runs the outsourced business has all the incentives to make money, not to solve problems. True, there are very commoditized businesses (like, say, office cleaning), but even in those areas territorial oligopolies or even monopolies eventually form through mergers and ackquisitions - the same tactic Bain employed elsewhere for the same reason - while all the profits, obviously, go to shareholders, not to workers. The very said monopolies or oligopolies often skew the salary picture within the occupation, eliminating the competition for a given worker within industry within a territory.

Things get even worse if people become reliant on existing infrastructure, like in IT, where it may be very hard to find a different support for existing code base. Often, once the service provider realized that, the prices skyrocketed, killing all the savings for the business in process.

Problem #2: loss of expertise. It is very hard to project 10-15 years ahead where and how the company would make money. In the 90es, there would be a lot of calls for Amazon to outsource the Web site hosting and maintenance and focus on core business; these days, it is that "outsourcable" activity that drives Amazon's profits as their API is used extensively by other parties. And such examples are numerous: consultants like Bain are inheretidly a lot better at explaining you how you make money than actually making it - Romney never ran anything other than consultant.

As a result, Bain did a lot of disservice to a lot of companies. In fact, US tech advantage decreased significantly over the 90es and, particularly, 2000's. Romney cut R&D and investment in a lot of companies - since his "long term capital gains" are actually very short term, so for him it would be the "flip and run" strategy.

AE,
Your classic example about workers who lose their jobs because they are shipped overseas was well articulated. I'd just like to elaborate on it.

The example AE raised also applies to domestic relocations. I once worked at a busy call center in Virginia managing a group of customer service representatives. The company learned that it could save significant labor (and other) costs by moving the operation to Montana. One year later, the operation was in Montana. Lots of Montanans picked up the jobs that we in Virginia had lost. My workers could not easily pick up other jobs (because other companies realized that their skill set was cheaper in other parts of the US, or the world...), hence they lost.

Economically and politically, I see no difference between shipping jobs overseas to make a greater profit, and shipping them interstate to make a greater profit (based on the above experience).

So my question for angry redundant workers would be 'Why demonize one and not the other?' More importantly, at election time, who would they hold responsible and why? Decisions like the one in my experience are taken by managers appointed by shareholders. They are not accountable to common voters, and have nothing to fear from them.

I understand the frustrations of those who lose their jobs as a result of economic realities; I've been there myself. But the author of this piece makes a very profound point in his last sentence.

A.R. follows an interesting logic with his agglomeration argument, that I did not expect in TE. Basically, your calling for new trenches of a class struggle. That under the new circumstances, the classical struggle cannot be fought because labour does not have fixed places. So, what people cannot talk about easily now, is basically this, how is class struggle under these new circumstances (technologies, etc.) possible? To put it in a different way, the whole liberal talk about rights, law and order is discarded as trash, and the rest is struggle. Interesting point, I have to say.

I think that with respect to Mr Romney, the important question is how does he now perceive his role in outsourcing a decade or more ago?
Has he come to understand and empathize with the argument made by your strawman Krugman? Does he see or deny the increasing domestic tensions in that perception of our current labor malaise?
Does he understand the argument you are making? Is he able to look forward and accept the challenges that throwing open the globalization gates, with essentially no controls on how multinationals are engaging the new playing field? It will require that he throw the reigns on his fat cat buddies on wall street and main street, those he helped outsource years ago.
Is he willing to build support for international institutions that start forcing globalization on a race to the top, where countries that embrace solid corruption, labor, and environmental laws get the jobs?
OR will he continue our current path, which seems to be a race to the bottom, where the worst, cheapest #@!$hole countries on earth get the jobs, where multinationals of all stripes have been known to engage in the worst forms of crony captiatlism, wage supression, environmental degredation, and human rights violations in the name of profit?

Much of the fault lies on labor's side. Famously, the United Auto Workers had negotiated a contract that paid a laid off employee almost 95% of his salary for not working! Had labor been satisfied with negotiating safety and pay only instead of demanding all kinds of concessions (in Montgomery County, Maryland, the police union had authority about everything such as their uniforms or kinds of batons!) their jobs would not probably have been offshored as much. In Canada, the postal service was notorious for annual strikes till the government outsourced much of their activities to the private sector. Thus, the main culprit, it seems, is very strong unions and their endless demands.

To me the statements in the two quotes don't contradict each other. It is true that a lot of workers migrate from less industrialized to more industrialized countries (second quote). There they benefit from a better health care system and probably better (compared to where they came from). On the other hand, those workers might replace higher-paid workers in the industrialized countries (first quote). The overarching question is, in what direction are we moving in the bigger picture?

The point being made about Romney is that his past at Bain offers no reason to believe that he cares about the middle classs, or that he would be unhappy with an economic policy that raises GDP where more than 100% of the benefit accrued to the top 1%.

I agree that offshoring might also benefit poor foreign workers - a good thing, but don't expect the displaced US workers to see it that way. Also, I fail to see how stripping employees of their benefits and calling them contractors does anything more than transfer wealth from the middle class to the wealthy "job creators".

I haven't seen anything specific that Romney is proposing that conflicts with that view, but he is free to convince me otherwise.

Thank you for reminding everyone that Paul Krugman used to stand for even tempered reasonable-ness, only more recently trading on his credentials for political validation - saying only what the crowd will applaud

A1. Depends on your point of view. Globalization did one thing across the world: it devalued labour in favour of assets and capital across the world. True, salaries in China rose; but asset prices rose even more. So, if you happened to already have a condo in Shanghai, it might have delivered, but if you're a country boy, your luck might just got worse.

What's even worse, globalization worsened the process of getting the world democratic and mindful of human rights. China and Russia strictly breed totalitarian state, and I would describe both states as very similar to multiple fascist (not Nazi) states between both World Wars.

I dont know that this is true necessarily...altho some of what krugman has said lately makes one wonder. But, one could just as easily argue that krugman was just riding the same wave of naive optimism that globalization would lead to pareto optimal results; that american markets would adapt and innovate to make up for low production value job losses; and that fast forwarding to 2012 has put a cynically realistic tone in his writing; chastizing those who've taken advantage of and gamed the global market system to everyone's detriment; that the krugman of today sees the mistakes he made yesterday, but perhaps, as RA suggests, fails to see the forest for the trees looking forward....again.

Outsourcing does not imply offshoring, and offshoring can occur without outsourcing.
Outsourcing is contracting with a third party to perform functions formerly performed by employees. Many U.S. companies have outsourced building maintenance, snow removal, and window washing, but they are not shipping their buildings overseas to have this done.
Further, offshoring can occur without outsourcing, since work moved overseas may still be done by employees of the company or its subsidiaries.
So one can outsource without offshoring, offshore without outsourcing, or outsource with offshoring. Too bad the Economist and our retarded president cannot understand this.